Analysis: Clock ticking for Ireland's sovereign wealth fund

LONDON Tue Nov 23, 2010 8:48am EST

LONDON (Reuters) - Ireland's 24-billion-euro sovereign wealth fund could disappear long before it gets to plug the pension shortfall it was originally intended for as Dublin is expected to use more of the stash to fix its banks.

On one level, there may never be a more appropriate time to tap a "rainy-day" fund of savings. But using up tomorrow's savings today breaches the fund's original mandate and illustrates how the fate of these funds (SWFs) fate is ultimately dictated by sponsoring governments.

Moreover, it could call into question the $3-trillion SWF industry's billing as a provider of global financial stability geared to invest in long-term assets regardless of fleeting market panics and disruptions.

Originally, withdrawals from the National Pensions Reserve Fund (NPRF) could not take place before 2025, when the government plans to supplement the cost of Ireland's social welfare and public service pensions between then and 2055.

However, Ireland has amended the rule and used 7 billion euros from the 9-year-old fund to recapitalize banks in 2009. It plans to tap a further 3.7 billion euros for the banking sector and European Minister Dick Roche has repeatedly indicated the pension fund is part of an available cash buffer for Ireland.

In order to finance the 7 billion euro investment, the NPRF sold all of its sovereign bonds and used all cash balances. Subsequently, in order to reduce heavy equity weighting, the fund sold 2.7 billion euros of equities in 2009.

"Would the manager have taken the decision with profit considerations? The answer is no. It is a perfect example of political pressure and decisions being forced upon them," said Andrew Ang, adviser to Norway's SWF and an associate at the U.S. National Bureau of Economic Research.

"The original aim was to pay for pensions, not to bail out banks. Consequences are that in a few years it ceases to exist or becomes a mere shadow of what formally was and there's no way the fund can meet its original intension to pay for large pension liabilities."

The NPRF is a founding member of industry group International Forum of Sovereign Wealth Funds established in 2009, which includes the world's biggest funds like Abu Dhabi Investment Authority or China Investment Corporation (CIC).

Their voluntary code of practice, the so-called Santiago Principles, states that an investment policy should be consistent with its defined objectives and based on sound portfolio management principles.

"You set up the fund with some purpose, ensure that purpose can be attained and set up an optimal corporate governance structure, and it clearly failed in Ireland's case," Ang said.

Despite its attachment to the world's elite SWF group, the NPRF's funding position is different from other mainstream funds like CIC or Norway's, which manage export windfall revenues.

The NPRF, initially funded out of a one-off cash transfer from telecom privatizations, relies on the government to top it up each year from its coffers.

CHANGING MANDATE

As a result of the government-directed move to buy preference shares of Bank of Ireland and Allied Irish Bank, the NPRF's portfolio was split in two. The component that holds these banks has already lost 400 million euros, while the other portfolio made a healthy 20 percent last year.

"The NPRF is now positioned quite differently for the next phase of its investment, compared with its portfolio and investment strategy since its inception in 2001," Paul Carty, chairman of NPRF, said in an annual report earlier this year.

The NPRF has a new objective of outperforming the cost of government debt over rolling five year periods by reducing equity weightings and enhancing allocation into alternative products, such as emerging markets and infrastructure.

Ireland's sovereign borrowing cost remains high above 8 percent, some 554 basis points above Germany's.

Ireland is expected to receive up to 90 billion euros in Europe/IMF loans. It is also expected to cut 10 billion euros in public spending and raise 5 billion euros in tax in the next four years.

SOURCE OF MONEY

Ireland is not alone in dipping into its sovereign fund to revive the economy, although it may be the first one to change its mandate to do so.

Kuwait's sovereign wealth fund spent at least 1.5 million dinars ($5.35 billion) late in 2008 to stop a slide on the local bourse and helped banks raise fresh capital in 2009.

Kazakhstan's Samruk-Kazyna has also bailed out the domestic financial sector hit by the credit crisis, spending $9 billion transferred from the government to bail out banks.

Unlike Ireland's NPRF, both funds have wider objectives, which allow them to rescue troubled domestic firms if needed.

Moreover, the NPRF's funding position -- where it relies on the already heavily indebted state for cash -- is making it hard to ringfence capital in times of the crisis.

"For a nation facing the financial crisis, actual stocks and bonds held by the government are higher in the pecking order in terms of funding because it's a real source of money," said Garett Jones, economist and a member of Financial Markets Group at George Mason University.

"The real problem is future pension benefits are likely to be lower. The chronic problem is that voters are unlikely to believe future government promises."